Why innovation could not save Nortel

Matt Vella
28 Jan 2009

Two years ago managers of Nortel Networks (NT) unveiled a risky wager to transform the troubled telecom equipment maker through innovation and design. Their agenda included modernizing research and development, creating so-called future-proof gear, and experimenting with emerging technologies ranging form virtual worlds to Web 2.0. 'We're not tweaking; we're turning Nortel on its head,' John Roese, Nortel's chief technology officer, said last August, describing the changes underway.

Nortel was indeed turned on its head. On Jan. 14 the company announced it would seek bankruptcy protection. Analysts and innovation consultants alike say promises and buzzwords could not save the troubled equipment maker from sagging demand for phone gear and a crippling $4.5 billion debt load. Efforts to create new products and business either came too late or, worse, were far off-base. 'Investing in innovation is important,' says Ronald Gruia, a principal analyst with consulting firm Frost & Sullivan. 'But ultimately Nortel needed to make smarter management bets.'

Nortel embarked on an ambitious turnaround in 2005 under Chief Executive Mike Zafirovski, eliminating jobs and selling off businesses. In mid-2006, Zafirovski tapped Roese, a respected technologist, to revamp the company's flagging R&D organization.

Dabbling in second life

Roese began by reorganizing Nortel's roughly $2 billion in annual R&D spending, directing 20% toward emerging technologies, 60% at core businesses, and 20% at declining products. Previously, the bulk of spending went to support aging telecom products rather than develop new ones. Roese also expanded research partnerships with the National Science Foundation and the Defense Advanced Research Projects Agency to share the burden.

Adopting the language of business innovation gurus, he championed a so-called Incubation Program and Innovation Lab to identify and develop new technologies such as Web 2.0 applications that allowed employees to collaborate with one another online. Roese used a public blog to communicate with customers and attempt to re-establish Nortel as an innovator. His team even dabbled in creating virtual worlds similar to Second Life. (For a podcast with Roese, click here.)

But his efforts weren't enough. 'Twenty-eight months is hardly very much time to change a company culture,' says Jeneanne Rae, president of innovation firm Peer Insight in Alexandria, Va. Rae adds that companies with especially successful R&D outfits, such as Apple (AAPL), Boeing (BA), and Nortel competitor Cisco (CSCO), have perfected the process of moving innovations out of the lab and into the marketplace.

What's more, Nortel's effort to move into providing services and Web-based collaboration software were, according to Morningstar equity analyst Grady Burkett, viewed by many with 'an air of skepticism.' Burkett notes that many of the technologies championed by the refocused R&D department were also being pursued by competitors such as Alcatel-Lucent (ALU) and Cisco, both of which boasted of deeper pockets. 'The Web 2.0 projects just didn't seem to fit for Nortel,' he says, noting that some 40% of the company's business still comes from the core carrier business.

Ultimately, seeking bankruptcy protection may have been an acknowledgment that talk of innovation had failed to produce much that could give Nortel a promising future. With $2.6 billion in cash and a burn rate of about $300 million per quarter, the company could have trundled along, according to Nombura analyst Richard Windsor, but instead chose bankruptcy protection.

Roese left the company on Jan 2, writing in a farewell blog post, 'I was brought into Nortel to help correct many years of neglect on R&D"&brkbar;I am comfortable with [Nortel's] direction even if I am not a part of the path forward.'

Vella is a writer for BusinessWeek.com in New York.

Copyright 2000-2009 by The McGraw-Hill Companies Inc. All rights reserved.

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